Over the past decade, demand for solar energy has skyrocketed in the United States and abroad – a trend that is expected to continue well into the 2020s. Despite the consistent growth of this transformative market, investment into the solar sector has been volatile and met with mixed results.
Solar stocks, for instance, have taken investors on a wild ride time and again. There are several reasons for this, such as uncertainty in tax incentives, global trade restrictions and supply gluts. But there has also been a common thread to these historically unpredictable investments. Most publicly listed solar companies manufacture solar energy equipment, and solar manufacturing is a hyper-competitive business where bankruptcies, exits and consolidations are the norm.
Institutional investors must balance stakeholder demands for more sustainable portfolios with the need for consistent returns over a long period of time. So, what are the best options? Turns out, investing in solar energy projects rather than technology and manufacturing can deliver on both fronts.
Solar energy projects are developed under long-term contracts in which an off-taker (i.e. a utility or corporation) agrees to buy the power produced by the system for a fixed period of time. Now that many projects have been in operation for a decade or more, we have a wide data set demonstrating that solar projects are low risk, both as a physical and financial asset.
Below, I’ve developed a guide for finding the right vehicle for investing in this growing asset class.
YieldCos are similar to traditional utilities in that they own and operate energy assets, including solar systems, and sell the power to end users. Owners of YieldCo shares receive dividends based on the revenue of these operating assets. They tend to carry significant debt loads that are long-term and locked into fixed rates. YieldCos have a larger parent or sponsor that maintains equity ownership interest, and as equity investors they have to compete with developers and fund owners that are also trying to buy solar projects. This approach bundles owned operating assets to create a stream of cash and are marketed as growth vehicles that are attractive to dividend-seekers.
This one is more aspirational, as IRS rules don’t currently allow solar projects to qualify under Master Limited Partnership rules. But Congress is considering bipartisan legislation to change this, with significant support from the solar industry’s trade association.
MLPs are tax-advantaged, publicly traded entities that are prime for investors looking for fixed income assets with comparatively high yields.
This financing model is common to oil and gas and other steady growth industries. Since 1987, Congress has largely limited the use of MLPs to real estate and natural resources, and 90 percent of income must be generated by qualifying activities related to these sectors. Unlike corporations that issue stock, MLPs do not retain earnings for growth but distribute them to investors as they become available. In general, MLPs are considered low-risk, long-term investments that help the energy sector decrease the cost of capital and provide slow but steady income streams.
The renewable energy equity REIT invests in and owns real estate assets, just like a traditional equity REIT, but this model doesn’t fully support investments in solar projects due to previous IRS qualifications of solar panels providing an active function. Hannon Armstrong is the only REIT using the equity to finance sustainable infrastructure projects and invest in capital intensive projects like HVAC improvements in buildings, but the company’s ability to invest in solar projects is limited by the IRS rules.
The mortgage REIT is only just now emerging as an opportunity to invest in solar projects a process I have been a part of as a co-founder of RadiantREIT. The mortgage REIT invests into a fund that offers liquidity for solar developers, meaning investors are competing with banks to finance existing project pipelines, rather than with developers to buy projects. This reduces the interest risk and creates capital for small to mid-sized developers, which in turn will continue to bolster industry growth and provide more investment opportunities and greater returns. The mortgage REIT model was designed specifically for turning long-term, low-interest, stable cash flows (like what a solar project produces) into a portfolio with returns that are attractive to the equity markets.
Globally, green bonds accounted for $161 billion in investments in 2017 and are used solely for climate and environmental projects. The green bond model comes with tax exemption and tax credit incentives and are sometimes referred to as climate bonds. sPower, a renewable energy power producer, offers a leading example. The company issued some of the first widely distributed, back-levered bond financing on tax equity partnerships. By closing $498.7 million in investment grade, private placement financing with approximately $425 million of medium-term bank loans in 2018, the company eliminated the refinancing risk associated with previous short-term bank loans.
This brief guide is intended to provide you with a starting point in your solar energy investing research. Ultimately, it is important to recognize that you can participate in the booming industry without taking on the risk and volatility of solar equipment stocks. As the market continues to grow and evolve, institutional investors will seek investment vehicles that allow them to achieve their target yields. This inflow of capital will create a virtuous cycle in which cheap, abundant capital enters the solar market, enabling more growth and thus more investment opportunities.
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Jeff Just is the CEO and Co-Founder of RadiantREIT. He has founded and operated businesses for over 30 years, with multifunction experience in development, acquisitions, finance, and asset management. He was Founder and President of Dianet Communications, a company that designed and built multiple, large-scale, complex Distributed Antenna System (“DAS”) projects. He negotiated multiple large financings, including a $200 million DAS network in the New York City Subway system through a subsidiary, Transit Wireless, which eventually grew to a valuation of over $1 billion.